Chapter 10: Capital Budgeting Basics Flashcards
value of a project
project cash flows discounted at risk adjusted weighted average cost of capital
Project net present value
discounted future cash flows expected from a project less the initial project costs (essentially discounted present value of expected cash flows including initial costs, so must consider which cash flows are negative)
Measure of wealth the project contributes to shareholders
single best criterion for project decisions
cashflows at time 0 are not discounted
relationship between project NPV and MVA
Market value added = sum of all project’s net present values
capital (for sake of capital budgeting)
long-term assets used in production
capital budget
summary of planned investments of assets that will last for more than a year
Capital budgeting
the process of analyzing projects and deciding whether they should be included in the planned expenditures on fixed assets
Categories of projects
- replacement needed to continue profitable operations
- replacement to reduce costs
- expansion of existing products or markets
- expansion into new products or markets
- contraction decisions
- safety and/or environmental projects
- other projects
- mergers
grouping within project categories
projects grouped by costs with larger investment requiring more detailed analysis
first step in project analysis
estimate project’s expected cash flows
risk reflected in weighted average cost of capital
average risk of all company’s projects. (risk of an individual project may be lower or higher)
Project evaluation measures
- net present value
- internal rate of return (IRR)
- Modified internal rate of return (MIRR)
- profitability index (PI)
- Regular payback
- discounted payback
Second step in project analysis
calculate project evaluation measures
Net present value
the present value of a
